Legendary fund manager Li Lu (who Charlie Munger backed) once said, 'The biggest investment risk is not the volatility of prices, but whether you will suffer a permanent loss of capital. So it might be obvious that you need to consider debt, when you think about how risky any given stock is, because too much debt can sink a company. We can see that Nanjing Sinolife United Company Limited (HKG:3332) does use debt in its business. But the more important question is: how much risk is that debt creating?
What Risk Does Debt Bring?
Debt is a tool to help businesses grow, but if a business is incapable of paying off its lenders, then it exists at their mercy. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. However, a more frequent (but still costly) occurrence is where a company must issue shares at bargain-basement prices, permanently diluting shareholders, just to shore up its balance sheet. By replacing dilution, though, debt can be an extremely good tool for businesses that need capital to invest in growth at high rates of return. When we examine debt levels, we first consider both cash and debt levels, together.
What Is Nanjing Sinolife United's Net Debt?
The image below, which you can click on for greater detail, shows that Nanjing Sinolife United had debt of CN¥37.5m at the end of June 2019, a reduction from CN¥57.5m over a year. However, its balance sheet shows it holds CN¥140.0m in cash, so it actually has CN¥102.5m net cash.
How Strong Is Nanjing Sinolife United's Balance Sheet?
Zooming in on the latest balance sheet data, we can see that Nanjing Sinolife United had liabilities of CN¥139.6m due within 12 months and liabilities of CN¥32.5m due beyond that. Offsetting this, it had CN¥140.0m in cash and CN¥73.4m in receivables that were due within 12 months. So it actually has CN¥41.3m more liquid assets than total liabilities.
It's good to see that Nanjing Sinolife United has plenty of liquidity on its balance sheet, suggesting conservative management of liabilities. Due to its strong net asset position, it is not likely to face issues with its lenders. Succinctly put, Nanjing Sinolife United boasts net cash, so it's fair to say it does not have a heavy debt load! The balance sheet is clearly the area to focus on when you are analysing debt. But you can't view debt in total isolation; since Nanjing Sinolife United will need earnings to service that debt. So if you're keen to discover more about its earnings, it might be worth checking out this graph of its long term earnings trend.
Over 12 months, Nanjing Sinolife United made a loss at the EBIT level, and saw its revenue drop to CN¥384m, which is a fall of 14%. We would much prefer see growth.
So How Risky Is Nanjing Sinolife United?
We have no doubt that loss making companies are, in general, riskier than profitable ones. And the fact is that over the last twelve months Nanjing Sinolife United lost money at the earnings before interest and tax (EBIT) line. Indeed, in that time it burnt through CN¥60m of cash and made a loss of CN¥159m. But at least it has CN¥102.5m on the balance sheet to spend on growth, near-term. Even though its balance sheet seems sufficiently liquid, debt always makes us a little nervous if a company doesn't produce free cash flow regularly. For riskier companies like Nanjing Sinolife United I always like to keep an eye on whether insiders are buying or selling. So click here if you want to find out for yourself.
If, after all that, you're more interested in a fast growing company with a rock-solid balance sheet, then check out our list of net cash growth stocks without delay.
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